Unifin Financiera SAB de CV

BMV:UNIFINA

Earnings Call Transcript 2019-Q3

[Operator]

Good morning and welcome to UNIFIN's Third Quarter 2019 Conference Call. [Operator Instructions]

For opening remarks and introductions, I would like to turn the call over to Mr. David Pernas, Head of Corporate Finance and Investor Relations at UNIFIN. Sir, you may begin.

[David Sánchez, executive]

Good morning, everyone. Thank you all for joining us today to discuss UNIFIN's Third Quarter 2019 Earnings.

In the conference call, UNIFIN's senior management team will discuss the company's third quarter 2019 results as per the press release published yesterday. If you have not yet received a copy of the earnings release, please contact the Investor Relations team or you can find it on our website.

First, I would like to remind you that forward-looking statements may be made during this conference call. These do not necessarily consider changing economic circumstances, industry conditions, the company's performance or financial results. As such, these forward-looking statements are based on several assumptions and factors that could change, causing actual results to materially differ from current expectations. Therefore, we ask you to refer to the disclaimer located in the earnings release prior to making any investment decision.

We are very pleased to introduce Sergio Camacho, Chief Executive Officer; and Sergio Cancino, Chief Financial Officer.

At this time, I would like to turn over the call to Sergio Camacho for his presentation. Sergio, you may begin.

[Sergio Camacho Carmona, executive]

Thank you, David. Good morning, everyone, and thank you all for joining us today.

Despite the challenging macroeconomic environment in Mexico, we post strong results proving the resilience of our business model as well as new initiatives implemented throughout the quarter. In the third quarter, investors were increasingly concerned about the global economic slowdown primarily due to rising commercial tensions between the U.S. and its key trading partners, specifically China. In response to these negative economic outlook, the central banks of the main developed countries eased their monetary policies accordingly, leading to a reduction in the yields of sovereign bonds and the depreciation of most currencies against the U.S. dollar. Nonetheless, recent monetary stimulus should offset some of the current economic headwinds.

Mexico experienced similar trends. Yields of domestic bonds continue to decline. The Mexican peso depreciated against the dollar and the stock market fell slightly. Lower government spending and a significant contraction in company's gross fixed investment has significantly affected economic growth, which in turn has had a direct impact in UNIFIN's originations. Despite the slowdown, exports continue to contribute positively to the economy. Moreover, during the third quarter, the Bank of Mexico made some reductions in the interest rates by 25 basis points in both August and September. These cuts and the expectation of more to come in the current and upcoming year shall provide additional support to the economy. Furthermore, an increasing government spending and continued strength of the exports to the U.S. and robust growth of remittances from abroad and social programs should help boost consumption and product investment, improving the overall economic outlook.

The company's fundamentals have been mainly in line with our expectations as we closed the quarter with growth in the interest income and financial margin compared to the third quarter 2018. Our interest income grew 27% to MXN 2.9 billion in the third quarter compared to MXN 2.2 billion in the third quarter of 2018. The financial margin increased 16% and the net interest margin reached 7.6%, a 40 basis points expansion versus the third quarter of last year. As of September 30, our net loan portfolio ended at MXN 54 billion, an increase of 25%; and our total assets increased by 29% year-over-year at the end of the third quarter, reaching MXN 75 billion.

As is customary in our business, there is a lag between issuing new debt and putting those funds to work by offering new leases and financing to our clients. Particularly, this lag impacts our financial margins in the short-term negative carry.

Going forward, we expect profitability to recover as we deploy our cash balances. For the remainder of the year, we expect market trends to improve with the economy. This will bode well for new products we are developing, which will help strengthen our relationship with current clients as well as expanding our client base and reduce operational costs. We plan on launching 2 products. One consists in placing a working capital facility to our clients based on their payment history with a cross-default clause; and the other is a sophisticated tech platform as a new means of contact for leasing or customer support, which will also allow for cross-selling and upselling in the midterm.

On August 8, UNIFIN successfully made an offer of debt securities in the form of bonds in the international markets for an amount of $200 million with an annual interest rate of 7%. The maturity date is set for August 2022. It is important to highlight that this issuance was done after the company received a reverse inquiry by an institutional investor. This, together with a syndicated unsecured loan for 2,000 -- $220 million issued in July and the private offering of senior notes in international markets of $450 million at an annual interest rate of 8.375%, put us in a strong position to close the year. These resources will be used for general corporate purposes under repayment of short-term trade facilities, maintaining the cost of debt in line with our expectations for 2019 at approximately 10.7%. Finally, I am glad to mention that Standard & Poor's affirmed UNIFIN's rating of BB on a global scale, reaffirming UNIFIN's sound financials.

Although we anticipate that the last quarter of 2019 will continue to be challenging in some respects, we are convinced that UNIFIN core fundamentals are strong enough to withstand this cycle and we are well prepared for the future. We will continue to take prudent decisions and maintain a conservative risk management approach. We remain confident in Mexico's long-term economic outlook, and we'll continue to support the small- and mid-cap broader strategies by satisfying their investment needs. We reaffirm our commitment to our stakeholders by continuing our efforts to improve the profitability of the company.

So now regarding our business trends for the quarter, moving on to the financials. UNIFIN was not immune to the challenging economic environment. As we said in our previous call, economic uncertainty has translated into slower decision-making process for some of our clients, resulting in lower originations in the leasing business. The company's countercyclical efforts have translated into a backlog of MXN 14.5 billion. This backlog considers approved lines of credit awaiting to be disbursed by the client. However, the conversion rates have slowed from 75% in 2018 to 50% in the 9 months of this year, explaining the drop in originations. Despite this slowdown, we managed to close the quarter with a growth in total interest income of 27% versus the same period last year. Interest expense rose 38% to MXN 1.9 billion due to the financing of the company's operations and issuing of new debt. During the third quarter, the weighted average funding cost was 10.7% compared to 9.9% in the third quarter of last year. The 78 bps increase in the funding cost was mostly caused by an incremental debt and an increase in the overall cost of funding.

The financial margin for the quarter was MXN 875 million, a growth of 16.2% compared to the third quarter of last year. The increase in the financial margin is related to our sales platform. As a result, the NIM for the quarter increased 40 bps to 7.6%. The financing result, which consisted of bank commissions and fees in addition to gains related to our foreign currency, cash assets and liabilities, ended with an income of MXN 47 million for the period.

Administrative expenses consisting of investments in marketing and promotions, administrative services, legal, professional fees and other administrative expenses reached MXN 314 million, a 15% increase when compared to the third quarter of 2018. Our marketing campaign and a higher headcount accounted for most of this expense and explained the increase from the third quarter of last year. However, operational expenses as a percentage of sales improved 110 bps to 11% compared to 12% in the third quarter of 2018.

Moving on, our operating income fell 5% to MXN 591 million in the third quarter from the MXN 623 million reported in the same quarter of last year. As a result, the consolidated net income from the quarter also decreased 16% and ended at MXN 471 million from the quarter compared to MXN 562 million in the third quarter of 2018.

Total originations, especially the addition of new loans in the last quarter, has increased the net loan portfolio by 25% compared to the third quarter of last year, reaching MXN 54 billion. The NPL, which considers all past due loan portfolios of our businesses, was contained at 3.9% of the total portfolio in the third quarter. Of the total net portfolio, leasing accounted for the majority at MXN 39 billion.

The loan loss reserves stood at MXN 1 billion, an increase of 21% compared to the third quarter of last year. These provisions are created in accordance with our reserve for loan losses policy, which is attached to the guidelines defined by IFRS. The methodology is based on an expected loss basis. The factors we use to determine expected loss provisions for the leasing portfolio are historic payment behavior, current environment and reasonable provision for future payments. The financial liabilities at the end of September were MXN 60 billion, an increase of 38% compared to the third quarter of last year. The increase in these liabilities stemmed from acquiring 3 new loans during the quarter. The weighted average term of the liabilities in the quarter was 54 months versus 33 months of the total portfolio.

Furthermore, in the third quarter, the fixed-rate debt accounts for 94% of the total debt, in line with our prudent financial strategy. Stockholders' equity rose to MXN 9.8 billion, a positive change of 5% compared to the figure in the third quarter of last year. The variation in shareholders' equity is explained by higher-return earnings as a result of improved profitability.

So with that, I will -- appreciate your listening, and I would like to begin with our Q&A session.

[Operator]

[Operator Instructions] Our first question comes from Carlos Rivera of Barclays.

[Carlos Rivera Zermeno, analyst]

My first question is regarding the leverage of the company. Obviously, there were substantial amount of funds that were raised in the quarter. But during the last conference call, I asked about the trends for the leverage. And I think we discussed a little bit about the outlook for the next few years and it was to improve. So if you could put a little bit in context the increase that happened this quarter and how you see the trend over the next quarter to get to the improving part, when do you see that stabilizing and probably over -- from what level?

And my second question is regarding asset quality. A small increase this quarter-over-quarter in the NPL ratio, but basically, the bulk of increase happened in prior quarter. So is that driven by a specific client? Is the situation that you mentioned specific to 1 client? In the prior quarter, we saw that it's still there. Is this due to any specific economic segment? Any color that you could give us about this one and what is your expectation for the next quarters in terms of asset quality would be great.

[Sergio Camacho Carmona, executive]

Carlos, this is Sergio Camacho. Regarding the leverage, the -- as we have previously said, the outlook, it's on a reduction mode, let me put it that way. The reason why we have this effect on the third quarter is because we have this -- as we've said on the call, a reverse inquiry by this institutional investor that we took advantage of. And that, of course, increased the leverage on a significant way. However, what I can tell you is on the fourth quarter, you're going to see an improvement of that based on our current plans.

Regarding the NPL, yes, I mean we have seen a slight -- let me put it this way, deterioration across the board, particularly with the slowdown on the economy. All of these clients that somehow have indirect impact or direct relationship with the government had -- are suffering in terms of cash flows. Although we do not have a direct exposure to the government, it's a sentiment across the whole Mexican economy that there are less money available and there's less money within the economy as a whole. So that, of course, has put some pressure on our NPLs. However, all the measures that we've put in place at the beginning of the year have been sufficient to maintain a very healthy NPL, below 4%.

[Carlos Rivera Zermeno, analyst]

Okay. And just a follow-up on the asset quality, do you see it going down in the next quarters? Or we could just still see some lagging effect or some residual effect of the economy still being kind of weak, translating into higher NPLs in the next quarters?

[Sergio Camacho Carmona, executive]

No. I think that we're going to maintain the same levels that we are posting right now. I do not expect neither a further deterioration or a significant improvement. Because even though we have heard and we are seeing now that the government is moving on, it's going to take some time until the full effect of this government spending is put in place.

[Operator]

The next question comes from Nicolas Riva from Bank of America.

[Nicolas Riva, analyst]

My first question is on capital. It's kind of a follow-up on the question that Carlos was asking before. So if I look at the equity to net loans, which now is the number that you have in the covenants of the USD senior bonds, meaning 13.5%, it has declined once again this quarter, 18.2%. And again, the trend from some quarters has been a decline. At what point of that equity to net loans would you consider raising more equity? So that's the first question.

Second question. I remember that in the past when just you said that you expected the capital ratio to remain more or less stable, I was looking at some projections. And of course, there are different ways to get to a stable capital ratio. But if I assume 20% loan growth next 12 months, more or less MXN 500 million per quarter net income, MXN 2 billion per year or a 20% ROE on a 20% dividend payout, I get to that more or less stable capital ratio equity to net loans. Do those assumptions more or less make sense, the 20% loan growth next 12 months, 20% ROE or MXN 2 billion in net income a year? So that's the second question on the guidance. What guidance you can give for those numbers?

And then third, growth. So if I look at growth year-over-year, the leasing portfolio or the total portfolio, the 25% year-on-year, it still looks strong. But if I look at just that origination, how much pesos you're originating new leases? There's been a substantial decrease, slowdown this quarter, MXN 3.7 million. And you mentioned the uncertainty in Mexico. For the fourth quarter, what are you seeing in terms of origination? And also, you just explained the new products in this working capital facility. Is that going to be unsecured very short term? And what's the target in terms of how much this working capital loans, how many percent of your total loan book?

[Sergio Camacho Carmona, executive]

Well, let me first start with the last question. On the originations, yes. I mean we experienced, I will say, a significant slowdown in third quarter. It was somehow like a perfect storm because we have the seasonality effect on vacations, which is an effect that we have had in the past. So that was coupled with a significant reduction in the expectations for growth over the year. If you analyze the recent developments on analysts on GDP expectations for the year or next year were reduced significantly in this, let's say, past 3 months. And that, of course, post a negative sentiment on the development on the Mexican economy. And that, of course, delayed some of the decisions of our clients. The numbers that we have already disclosed within this call, a call for roughly 2,000 clients that we have already approved, that we have already agreed with the assets and made all the whole credit analysis, that account for MXN 14.5 billion. So those are waiting -- I mean we're waiting there just to close the deal, let me put it that way. And of course, that post a significant -- a positive sentiment on our side to have a recovery in the fourth quarter and going forward.

The working capital facility that we already announced is within our current clients that have shown a really excellent track record on payments, but very, very important, putting them a cross-default clause. And that made them secured lending because of this cross-default clause that it's in line with the asset or the collateral for the facility. A capital that you mentioned, I would say that I agree with you on the assumptions that you're taking on your model. However, all these products that we're going to be launching as -- these 2 that we have already announced and some that are coming that we're -- are on the pipeline are intended to, one, increase our number of clients, improve the cross-selling of the products, but more important, are going to be more profitable products. And that of course going to put some improvements on our earnings generation.

And then what was -- what is the...

[Nicolas Riva, analyst]

Yes. And then the first one, at what point of the equity to net loans would you consider raising more for the equity capital?

[Sergio Camacho Carmona, executive]

I will say that we will be very keen on the analysis, below 15%.

[Operator]

The next question comes from the line of Joe Kogan from Scotiabank.

[Joe Kogan, analyst]

I wanted to follow up on the questions about origination. How can I figure out, what's the level of leasing origination that would have to be ongoing for a few years to at least maintain the leasing portfolio at the current size? I mean should I just be taking MXN 33 billion and dividing by 38 months? Or is there more to it than that?

[Sergio Camacho Carmona, executive]

Yes. You are correct. It's around MXN 1 billion per month.

[Joe Kogan, analyst]

Okay. And can you talk about the backlog that you mentioned at the beginning as far as what that is and how clients are making decisions, whether to take it or not? Just because everyone is, of course, watching growth, and it would help to understand when we might see some of that backlog actually come into origination.

[Sergio Camacho Carmona, executive]

I think it's -- I mean let's first be clear that the driver for decision to -- of our clients has to do with CapEx, basically. It can either CapEx or maintenance CapEx. And the CapEx, of course, is based on expectations. And that's what we have been trying to explain on -- in this call, that there has been a significant slowdown on expectations or reduced expectations on the GDP growth for the economy this year or next year. And that, of course, delay the decision on our clients to do an investment for their businesses. And that's basically the rationale that we're seeing.

[Joe Kogan, analyst]

All right. And I think those -- just the last question with regards to origination. You mentioned some additional marketing expenses, and could you talk a little about where those are targeted? Is it for new clients? Is it for new businesses? And what have been the results of those?

[Sergio Camacho Carmona, executive]

It is for new clients, basically. And the results -- I mean if you see our results compared to what has been the -- let me make some history. If you remember, at the end of last year, all the analysts were calling for a 2.5% GDP growth for this year. Now everybody is getting between 0 to 0.5%. I mean actually, in the second quarter, we just -- we're very close to consider a recession in the economy. So if you consider that negative effect and now have been into consideration that -- and seen our results, I think all the initiatives, the countercyclical initiatives that we have carried out are -- have been very successful. So all of our marketing activities are intended to increase the number of clients, to increase the penetration of our products and to support the cross-sell of the different products that we have in our portfolio.

[Operator]

Our next question comes from Jamie Nicholson of Credit Suisse.

[Jamie Nicholson-Leener, analyst]

I'm interested to know a little more color about some of your comments you made on the NPL increase and how you said many of your clients have indirect exposure to the government and there was a slowdown there. I'm wondering if you have a -- if you can give us a breakdown of how many of your clients have exposure specifically to Pemex and whether those clients are experiencing delays that may be leading to an increase in their NPLs? If you can provide any color on that, that would be helpful. That's my first question.

[David Sánchez, executive]

Jamie, basically, the total oil and gas exposure of the company is probably around 3% all in all, considering indirect. And there are 3 different tiers that were attracting the clients, Tier 2, Tier 3, more specifically. So that will be the total exposure on oil and gas.

[Jamie Nicholson-Leener, analyst]

So only 3% of your total loan book?

[David Sánchez, executive]

Yes. That's correct.

[Jamie Nicholson-Leener, analyst]

Okay. Okay. And then my second question, you talked about analyzing new business opportunities, and I'm wondering if those are just related to the new products that you talked about or if you're considering any acquisitions.

[David Sánchez, executive]

We're targeting new products because we believe that we understand and know very well the SME market. And in terms of basically M&A or acquisitions, it really doesn't make much sense to target lower companies at this point because they don't provide much, much originations to us today. Also, all new originations are coming from investments and the countercyclical measures that we've done in the business intelligence approach to our clients, in the new approach that we have basically set up in the company for targeting new clients with this advisory business model rather than just approaching a traditional sales pitch and behaving a little bit more like sort of like a small or boutique-investment-bank-style operation. And that's more or less what we're focusing on.

[Operator]

Our next question comes from Guillermo Diego of Santander.

[Guillermo Delgadillo, analyst]

Just could you remind us, if you were to stop operations today and liquidate the portfolio of assets, what would be the value of that? Because it seems like you generate higher profitability, but trade at a 40% discount versus financial peers despite the fact that as a leasing company, you have the value of the portfolio as a collateral. And maybe could you also explain to us historically what have been, looking further the NPL, the actual nonpayment of a client or the actual [ quebranto ]?

[David Sánchez, executive]

I mean as we put on the chart on the press release, basically the breakeven, considering the current allowances made by the company and so on, is at 50% on liquidation value before closing additional impairments or the need of creating additional reserves. The historical realization value on the assets that we are leasing to the clients have been more close to 80%, okay, of that commercial value. But I mean just to give you -- if we were to realize all of the mix of assets today, I mean that's a completely different story, and I wouldn't be able to give you the figure for that.

[Sergio Manuel Rodriguez, executive]

And also, Guillermo, you need to remember that in addition -- I will say that around 80% of our leases had an additional guarantee. So it's -- I mean you have the natural collateral with the asset, but 80% of those leases had either a mortgage on the house of the owner or the personal...

[David Sánchez, executive]

Guarantee, the legal depositor.

[Sergio Manuel Rodriguez, executive]

The legal depositor. And some other things that somehow made a lease with another collateralization book -- sorry for that. So it is not just the asset. We have many other guarantees in place.

[Guillermo Delgadillo, analyst]

And just historically, what has been the amount of the actual -- of a client not paying on the actual hit in the books, not the NPL, but after all those collaterals and additional guarantees?

[Sergio Camacho Carmona, executive]

On leasing, I will say that over the last 5 years at least, there have been below MXN 50 million. We just had in the past quarter on the factoring, if you remember well that we write-off with our proper reserve around MXN 80 million on one client in factoring that was fully reserved and we decide to...

[David Sánchez, executive]

To try some write-off.

[Sergio Camacho Carmona, executive]

To do the write-off.

[Guillermo Delgadillo, analyst]

Great. And finally, are you expecting anything from these public/private program of infrastructure, the 1,600 projects? Do you expect any performance for the economy given your economic analysis?

[Sergio Camacho Carmona, executive]

Yes. And actually, we have been, over the last week, very close to these development banks, such as Bancomext, Nafin and Banobras, to somehow find a restructuring in which we can work together, trying to support all of these investments that this new administration had on plan.

[Operator]

Our next question comes from Jason Mollin of Scotiabank.

[Jason Mollin, analyst]

My question is on the shareholders' equity or book value, your book -- the change in year-on-year in the shareholders' equity. Despite -- in the third quarter, however, despite the MXN 470-of-approximate million in earnings, we saw the book value basically flat. And from what we see, this is partially attributed to the negative impact versus the valuation of hedges; second, to the cost of the perpetual bond that's booked in equity; and third, I believe this could reflect share buybacks. Can you go over the specific impacts in the change in shareholders' equity in the third quarter versus the second quarter? That's my first question.

[David Sánchez, executive]

Sure, Jason. Well, it's mostly basically the impact on the mark-to-market valuation of the hedging, which is relatively unpredictable because the most important variable there is, of course, the FX. But in addition to the FX, now there's also mark-to-market variations because of the current environment on reference rates. So those 2 combined generate a lot of volatility, which we haven't seen before. And the most important consideration on -- over the effect on mark-to-market volatility, the delta, over -- quarter-on-quarter, was specifically because of the rated -- reference rate change. So the valuations on mark-to-market change with that consideration. In addition to that, share buybacks were not something that posted any material effect on equity. The -- and that would be basically it. And they're perpetual. They're proportion of the perpetual bonds, like you said, which is...

[Jason Mollin, analyst]

But if I calculate -- sorry to interrupt, but if I calculate, I mean I take the hedging -- valuation of hedges was negative MXN 1 billion at the end of the third quarter, using a round number. In the second quarter, it was like negative MXN 850 million. So the quarter-on-quarter change is MXN 150 million. And so the earnings were for approximately MXN 470 million, so you have a negative hit there of MXN 150 million. Then the perpetual bond cost, I calculate on a quarterly basis of approximately MXN 131 million. And then you -- I mean I understand you bought back -- so I don't know how do you account for the buybacks, but I understand you bought back around 4 -- I think it was 4.8 million shares in the quarter. So even though they haven't been canceled, is that book -- is that -- when you buy -- I mean just using the current share price, that would be, whatever, like another MXN 130 million, MXN 140 million. And that basically gets rid of your -- almost gets rid of the earnings from the quarter. So is that what's going on? Or how long can the share buyback -- I think I can see very clearly the cost of the professional bond and the change in the valuation of the hedges. I'm not sure where I'd see the share buyback. Is that there? Or what else is going on in engine book value?

[David Sánchez, executive]

Sure, Jason. Yes. I mean you also need to include that depending on where is the coupon payment also had a negative impact or a deduction on the value on the mark-to-market. But I mean for the detail that you want to get into, let us schedule a different call providing you with all the disclosure on the different accounts on the capital structure.

[Jason Mollin, analyst]

Okay. My second question is on you mentioned the expectation of monetary easing. We're already seeing some. What is the sensitivity of only seeing net financial margin to 100 basis point change in the policy rate?

[Sergio Camacho Carmona, executive]

It will be very limited on the funding cost because, as we have said, 94% of our liabilities are fixed. And when you see the curves, even though we wanted to swap to floating rate, we'll need to expect a decrease on the reference rate of around 150 bps to have a benefit on that, so it's not -- that doesn't make any sense. The reason why we are highlighting the easing on the monetary policy has to do with the fact that, that is going to be something that can help to boost the economy as an overall, rather than of having a benefit to our business model.

[Operator]

Our next question comes from Manuel Alejandro from Signum Research.

[Operator Instructions] Our next question comes from Manuel Alejandro from Signum Research.

[Manuel Alejandro Zegbe Jones;Signum Research, analyst]

Sorry, I was having trouble with my mic. The question is regarding the new products you're expecting to release in the next month or the next few weeks from -- what are the -- can you give us more color about these new products? And how does this impact UNIFIN's growth and income?

[Sergio Camacho Carmona, executive]

I mean I can give you color on the definition on these new products. However, it's too early or we are in a very early stage to provide an indication on how it's going to impact the results of the company. The -- as I've said, one of these new products that is going to be launched in the -- within a few weeks is a working capital facility line to our current client in which depending on the size of their portfolio or the size of their lease, we're going to put some lead to provide with less than a 1 month working capital facility with a cross-default clause. And the other, we are developing a platform to better improve the penetration on the products. And somehow, it will have also some additional like credit facilities to new customers in order to capture them and trying to get any -- do the upsell -- upselling and cross-selling of the other products. And that's what I can tell you for the moment.

[Operator]

At this time, there are no further questions. I would like to turn the call back over to David Pernas for closing remarks.

[David Sánchez, executive]

Thank you all for joining us today and for your interest in the company. Please do not hesitate to contact us with any questions you may have. Looking forward to speak to you again. Have a good day.

[Operator]

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.